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Wednesday, September 07, 2011

The reversal of reforms on the New Pension System?

In December 2002, the NDA made a very big move in pension reforms. They decided that from 1/1/2004 onwards, all new staff recruited into the government would be switched out of the traditional defined-benefit pension and instead placed into a new individual-account defined contribution pension system. This was one of the major achievements of the economic reforms of that period. For a conceptual picture of the New Pension System (NPS), see this article, and for a story of that period, see this article.

An essential feature of the NPS was that it was a defined contribution system. India has a long history with getting into trouble with guaranteed returns. UTI's assured return schemes turned into a problem for the exchequer. EPS, run by EPFO, is bankrupt. When pension promises are made, they require peering into many decades into the future and arriving at estimates of longevity and asset returns. In the best of times, it is hard to make such estimates; honest mistakes are possible. In addition, when governance is weak, there are political pressures to make extravagant promises, which will look popular right now but generate staggering costs for the government in the future. As an example, rough calculations show that the implicit pension debt on account of the traditional civil servants pension in India (the one which was replaced by the NPS) stand at roughly 70% of GDP. This is a very big price to pay, for a tiny sliver of the workforce.

The NDA did the unpopular work of switching new recruits out of the defined benefit pensions. But the UPA did not follow through appropriately. At first, many years were lost in hoping that the CPI(M) would come on board the reform. After that, the legal engineering was put into place in order to get an NPS up and running without requiring the legislation. This process was slower than what one might have desired, but it has been making inexorable progress.

But now, a new existential threat seems to have come up : the Parliamentary Standing Committee on Finance seems to be saying that the fundamental idea of the NPS -- defined contributions -- should be scrapped. This would amount to a major reversal of India's economic reforms.

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